Angry in the Great White North

You might think accounting is boring. Don't let that stop you from reading this. It ends with murder.

As you recall from the post about the state of Ontario's cabinet under Dalton McGuinty, Dwight Duncan, the caretaker finance minister, released a budget in March. Buried in the document is a reference to the Canadian Public Accountability Board (CPAB):

The government is working with other jurisdictions and the Canadian Public Accountability Board (CPAB) to maintain an effective and well-functioning oversight system for audit firms, which supports public confidence in the integrity of financial reporting by public companies.

Is there a problem with accounting in Canada? Not that I know of, but then there have been the notorious cases such as the Enron bankruptcy in 2001 in the US. When those massive accounting failures became public, the US government reacted by creating the Public Company Accounting Oversight Board (PCAOB):

The PCAOB is a private-sector, non-profit corporation created by the Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports.

That quote comes right off the home page of the PCAOB, and the home page links directly to the legislative instrument, the Sarbanes-Oxley Act, that gave the PCAOB the statutory power to pursue its goals of overseeing the auditing of public companies. That huge act was created in the wake of Enron, WorldCom, and other scandals.

In Canada, we have the CPAB:

2002 July: Federal and provincial financial and securities regulators, as well as Canada's chartered accountants, announce the creation of the CPAB, a new independent public oversight system for accountants and accounting firms that audit reporting issuers.
2003 April: CPAB is incorporated as a corporation without share capital under the Canada Corporations Act
2003 June: The Canadian Securities Administrators (CSA) release draft rule 52-108 that would require auditors of reporting isssuers to be members in good standing with the CPAB

Created by regulators who issued a rule. Where is the legislation? Where are the statutes? And what Canadian problem was it designed to fix?

Well, the rule is pretty lengthy like a law. Here's a bit of it:

PART 2 AUDITOR OVERSIGHT
2.1 Public accounting firms -- A public accounting firm that prepares an auditor's report with respect to the financial statements of a reporting issuer must be, as of the date of its auditor's report,
(a) a participating audit firm, and
(b) in compliance with any restrictions or sanctions imposed by the CPAB.
2.2 Reporting Issuers -- A reporting issuer that files its financial statements accompanied by an auditor's report must have the auditor's report prepared by a public accounting firm that is, as of the date of the auditor's report,
(a) a participating audit firm, and
(b) in compliance with any restrictions or sanctions imposed by the CPAB.

It looks like a law but it isn't. It's a rule created by the OSC. A rule that was enacted in every other Canadian jurisdiction by the other member agencies of the Canadian Securities Administrators. Is the CSA a government agency? No:

The Canadian Securities Administrators (CSA) is a forum for the 13 securities regulators of Canada's provinces and territories to coordinate and harmonize regulation of the Canadian capital markets.

The CSA brings provincial and territorial securities regulators together to share ideas and work at designing policies and regulations that are consistent across the country and ensure the smooth operation of Canada's securities industry. By collaborating on rules, regulations and other programs, the CSA helps avoid duplication of work and streamlines the regulatory process for companies seeking to raise investment capital and others working in the investment industry.

So the various securities commissions get together under the aegis of the CSA, hammer out Rule 52-108, which is adopted by each member commission, and in doing so creates the CPAB, which has the power to determine who is and is not allowed to do audits.

Notice that no legislature is mentioned. No federal or provincial bill appears.

But there are rules. The OSC is allowed, under the Securities Act, to set rules covering matters that require 62 subsections under Section 143 to enumerate. Buried in there is subsection 25:

25. Prescribing requirements in respect of financial accounting, reporting and auditing for purposes of this Act, the regulations and the rules, including,
i. defining accounting principles and auditing standards acceptable to the Commission,
ii. financial reporting requirements for the preparation and dissemination of future-oriented financial information and pro forma financial statements,
iii. standards of independence and other qualifications for auditors,
iv. requirements respecting a change in auditors by a reporting issuer or a registrant,
v. requirements respecting a change in the financial year of an issuer or in an issuer's status as a reporting issuer under this Act, and
vi. defining auditing standards for attesting to and reporting on a reporting issuer's internal controls.

All this, and the 61 other matters, are given over to the OSC to determine the rules, without specific legislation. In the US, the PCAOB is created as a result of a specific piece of legislation. The CPAB is created by a rule cooked up behind closed doors at the CSA.

I say closed doors because though 143(2) lays down the requirements for publishing the rules and all the supporting documentation, 143(3) gives the OSC a huge loophole:

The Commission does not have to make reference to written material [with regards to new rules or rule changes] that, in the opinion of the Commission, should be held in confidence because it discloses intimate financial, personal or other information and the desirability of avoiding disclosure of the substance of it or its existence in the interests of any person or company affected outweighs the desirability of making it or knowledge of its existence available to the public.

OK, so the OSC makes a rule under its authority over audits and CPAB is created. Is there any legislative oversight? Yes, after the rule is delivered, as required by 143(3):

Action by Minister
(3) Within 60 days after a rule is delivered to the Minister, the Minister may,
(a) approve the rule;
(b) reject the rule; or
(c) return it to the Commission for further consideration.

Maybe it's not obvious to you, but it sure screams out at me. No debate! The Minister receives the rules, and signs off on it. That's it. No presentation to parliament, no legislative committees, no public discourse. Hell, not even a debate within cabinet. The OSC creates a rule, and a couple of months later, the Minister signs off on it.

What's worse is if the Minister forgets to sign off, the rule comes into force anyway, according to 143.4(2):

(2) If the Minister does not approve a rule, reject it or return it to the Commission for further consideration and a coming into force day,
(a) that is at least 75 days after the rule is delivered to the Minister is specified in the rule, the rule comes into force on the specified day;
(b) is not specified in the rule, the rule comes into force on the 75th day after the rule is delivered to the Minister; or
(c) that is within 75 days after the rule is delivered to the Minister is specified in the rule, the rule comes into force on the 75th day after the rule is delivered to the Minister.

Now how does this matter? Well, not everyone likes the rules, but there is little they can do about it. Consider the Certified General Accountants. How is a CGA different from a Chartered Accountant? Damned if I know, but the CPAB says CGAs are not allowed to audit publicly traded companies. Needless to say, the CGAs aren't happy:

(Ottawa, May 9, 2006) – Today, the Certified General Accountants Association of Canada (CGA-Canada) filed an Application for Judicial Review with the Ontario Superior Court of Justice to address longstanding concerns regarding the structure and processes of the Canadian Public Accountability Board (CPAB).

“CPAB – the body set up by governments and securities regulators to oversee the auditing of reporting issuers in Canada – is fundamentally flawed,” said Dany Girard, FCGA, Chair of CGA-Canada’s Board of Directors. “Because of CPAB’s close relationship to the profession it oversees, CGA-Canada believes that CPAB is unable to make independent decisions and lacks the procedural safeguards necessary to protect against institutional bias.”

Despite ongoing collaboration with CPAB and CPAB’s acknowledgement that the CGA independence standard is equivalent to the one CPAB has already recognized, CPAB has deferred its approval of the CGA independence standard and has not given effect to the required rule change.

And there's the rub. The CPAB was created by a cartel of securities commissions. Those commissions gave the power to the CPAB, their creature, to regulate auditors. That power was defined by a rule that the securities commissions are allowed to make without prior consultation with any legislative body, a rule that by default has the force of law unless a minister, acting on his own, explicitly rejects the rule. Neither the rule nor the minister's decision are presented in parliament or debated.

If these rules were legislative acts, CGA-Canada could present its case to the all-party legislative committee tasked to review the legislation and suggest amendments. The decision might still have gone against CGA-Canada, but at least it would have been a transparent process with democratic legitimacy.

As it is, CGA-Canada must pursue action in the courts, with the judge acting as a stand-in for the collective wisdom of our elected officials, none of whom were consulted on this rule, and of whom only one was asked to approve it.

Which brings us back to Dwight Duncan's budget. Recall that line in the budget:

The government is working with other jurisdictions and the Canadian Public Accountability Board (CPAB) to maintain an effective and well-functioning oversight system for audit firms, which supports public confidence in the integrity of financial reporting by public companies.

What specifically does this mean? What problem is being solved here? What oversight, exactly, is lacking? The OSC has complete discretion when it comes to defining what is an audit firm, discretion that has been invested into the CPAB, discretion that does not require legislation to enact. There is no need to even announce to the legislature what rules the OSC will enact.

Is the government planning to give the CPAB powers that go beyond what the OSC can grant that will make the CPAB more "effective"? It'll be interesting to see what those powers are, if that's the case.

And I look forward to seeing how the government does this. Standalone legislation? Or sneak it in the budget? But then it can't go in the budget because Greg Sorbara is barred from dealing with OSC-related decisions.

Yet I can't find any bill related to the CPAB being worked on for this sitting.

So the bottom line is that the Securities Act has granted the OSC the ability to bypass all the legislative checks and balances in regulating any number of securities matters, affecting the livelihood of people like the membership of CGA-Canada, who have no legislative recourse with which to deal with this quasi-legislative entity. And yet the budget says the Ontario government is going to become involved in the oversight of audit firms, a job for the CPAB as defined by the OSC.

Weird.

Now you might be asking, "What murder? You promised a murder!" Yeah, I lied. I just wanted to make sure you read the whole thing.